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01.29.15

Starting in business

If you inherit a stamp collection and sell it on eBay as a one-off transaction, then no tax is likely to be payable. There might be a theoretical charge to Capital Gains Tax, but in practice this is a relatively lenient tax and often the charge turns out to be nothing. However, if you make a habit of buying stamps as and when you can and selling them online, then you are now engaged in a trade and your profits are chargeable to Income Tax.

Income Tax is chargeable by a year running from April 6th of one year to April 5th of the next year (it’s the Feast of the Annunciation or Lady Day in the Julian calendar frozen at 1752 when we changed to the Gregorian calendar to be precise). After this year has ended, you have up until October 5th to tell HM Revenue & Customs about any new trade you have started or any capital gains you have made. If you miss this deadline, then you should tell them as soon as possible anyway, in which case you will be sent a paper tax return which you need to complete and return by October 31st. In practice meeting this tight deadline is impossible and you should contact an accountant such as us who will prepare accounts for you and then submit an electronic tax return by the electronic deadline of January 31st of the following year.

We have told you what to do if you drift into business by online trading, and you should know that Income Tax is definitely not a lenient tax, and in addition there are Class 4 National Insurance Contributions which are effectively a second tax. The other possibility is that you start a business deliberately. Many businesses start as a one-man or one-woman business or “sole trader”. Your accountant will prepare accounts and a tax return for you and submit them to HM Revenue & Customs. This is relatively informal and there is a relative lack of bureaucracy. However, if someone makes a legal claim against you, it is you as a person whom they are claiming against, and you could lose a lot of money if they are successful!

Two or more persons could start in business together as a partnership. Any profit they make is divided up between them in an agreed ratio, and then each partner is charged to Income Tax on his or her share of the profit. This is slightly more bureaucratic because a partnership tax return needs to be submitted as well. Often partnerships consist of a husband and wife, or two or more brothers and sisters, or two or more members of the same profession such as solicitors or accountants. There is some affinity between the partners. If the partnership gets sued, then all the members of the partnership are jointly and severally liable for each other’s misdeeds. If one partner does something wrong, and cannot personally pay all the damages, then the other partners need to make up the difference.

You can also start in business as a limited company. This involves more bureaucracy and accountant’s fees, but if you get sued then you can limit your liability to the assets of the company and your share capital. It is common to start a business as a sole trader for a number of years, and then to transfer the business to a limited company, which is called incorporation. Companies pay Corporation Tax instead of Income Tax or Class 4 National Insurance, and generally Corporation Tax is more lenient. A popular time to incorporate is when profits charged to Income Tax are so great that you start paying surtax. Note that incorporation does not give you any protection against creditors or claims arising prior to incorporation.

You could decide to start as a limited company from the beginning. With what we said about the joint and several liability of partnerships, this is an alternative to consider. The company can choose its own year for preparing accounts, which does not have to be April 5th. Small companies will need to prepare both accounts and a separate set of “abbreviated accounts” which needs to be published by sending it to Companies House so that anyone can download it and see it. This loss of privacy is the price to pay for limited liability.

Occasionally a business will choose to incorporate as an unlimited company. It gets the benefit of the more lenient Corporation Tax regime, and can keep its accounts private. However it loses the privilege of limited liability and its shareholders are jointly and severally liable for all the company’s debts, and not just liable in proportion to their shareholding.

Another occasional option is to incorporate as a Limited Liability Partnership. This gives limited liability, as it says, so accounts need to be filed at Companies House where anyone can view them. The partners are assessed to Income Tax. The LLP is best suited to members of certain professions which have their own special rules on the liability of members.

A very rare option is to set up a Limited Partnership. This has one general partner with unlimited liability, and a number of other partners with limited liability.

If a partnership is set up under English Law, then it is considered to be merely an association of its members and nothing more. If it is set up under Scots Law, then it is considered to be a body which has a separate existence from its members. Both a Scottish partnership and a Scottish company may collectively be known as a “firm”, a name which is also used informally in England to mean a company.

Some limited companies are set up for some public benefit rather than to trade. Instead of having shareholdings they have members each having limited liability, and such a company is called a Company Limited by Guarantee. As it stands, the CLiG can still make a profit, wind itself up and then share out the profit among its members, so it is still assessed to Corporation Tax every year. However, the CLiG can insert a clause in its articles required that its assets are handed over to a similar organisation in the event of winding up, and then register as a charitable company. In this case, it is exempt from corporation tax.

If a business provides goods or services in excess of £81,000 per year, then it may need to register for another tax, namely Value Added Tax. Generally the administration of this tax is anything but lenient, and involves the business charging VAT at an additional 20% on top of its sales, but being able to reclaim the VAT which it pays to its suppliers. VAT is a serious matter and something which you should discuss with your accountant.

Charities are exempt from Income Tax or Corporation Tax, but they may also need to charge Value Added Tax. If this is the case, it is common for the charity to have a trading subsidiary set up as a Community Interest Company. This is like a CLig but with rather complicated rules saying that it is exempt from tax as long as it hands over all its profits to its specified charity.